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FASB begins deliberations on alternative impairment model

  • FASB (US Financial Accounting Standards Board) Image

Aug 24, 2012

The FASB began deliberating an alternative to the “three-bucket” impairment model jointly developed with the IASB.

Note: At its August 1, 2012, board meeting, the FASB directed its staff to explore an alternative model to address significant concerns expressed by constituents about the three-bucket approach. See our earlier story for additional information.

The Board tentatively decided that:

  • The measurement objective of the alternative model would be expected credit losses (i.e., an entity’s current estimate of contractual cash flows not expected to be collected). Therefore, as of each reporting date, an entity would recognise a credit impairment allowance equal to its current estimate of expected credit losses. Furthermore, the measurement of expected credit losses would (1) be an expected value (i.e., a probability-weighted average of at least two possible outcomes) and not the most likely outcome and (2) incorporate the time value of money.
  • The alternative model would not include a recognition threshold (e.g., probable), and interest income would continue to be “decoupled” from credit losses (i.e., interest income would be based on contractual cash flows).
  • The information to be considered in estimating expected credit losses would include “all supportable internally and externally available information considered relevant in making the forward-looking estimate, including information about past events, current conditions, and reasonable and supportable forecasts and their implications for expected credit losses.”
  • The alternative model would not prescribe a unit of account (e.g., an individual asset or a group of financial assets) to be used in the measurement of credit impairment.
  • The recognition of impairment for purchased credit-impaired (PCI) financial assets would also follow the expected-credit-loss concept. Accordingly, upon acquisition, an entity would recognise an allowance for credit impairment equal to the estimate of the contractual cash flows not expected to be collected (measured in a manner consistent with the guidance on calculating expected credit losses discussed above). In subsequent periods, any changes in the impairment allowance — whether favorable or unfavorable — would be recognised immediately through earnings. Interest income recognition for PCI assets would include a yield adjustment for the noncredit premium or discount to par embedded in the purchase price but would exclude any discount to par embedded in the purchase price attributable to expected credit losses (i.e., the nonaccretable yield).
  • For financial assets measured at amortised cost, any unrealised loss (i.e., the difference between the fair value and the net carrying amount — that is, amortised cost net of any credit impairment allowance — of the asset) would be recognised through earnings when the entity determines that it intends to sell the financial asset. In contrast, for financial assets measured at fair value through other comprehensive income (FV-OCI), unrealised losses would only be recognised in earnings when the entity sells the financial asset.
  • Credit impairment should be recognised as an allowance — or contra-asset — rather than as a direct write down of the amortised cost basis of a financial asset.
  • For financial assets measured at FV-OCI, reporting entities would be required to disclose within the statement of financial position (i.e., parenthetically) the amortized cost net of the credit impairment allowance. Entities would disclose the information they use to reconcile the amortised cost of such assets with their fair value in the notes to the financial statements.

The tentative decisions reached about the alternative model would apply to all financial assets measured at either amortised cost or FV-OCI. However, the Board noted that its tentative decisions may change after it discusses the following open items:

  • The application of the model to debt securities.
  • Nonaccrual accounting.
  • The application of the alternative model to trade receivables, lease receivables, and off-balance-sheet items.
  • Disclosure requirements.
  • Transition guidance.

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